Sunday, January 13, 2013

Here's the short version of why forecasts of low long-term oil and natural gas prices are almost certainly wrong: It costs more than that to get the stuff out of the ground. Only two things could actually lead to low long-term prices: 1) Somebody could invent and deploy some genuinely brand new technology that makes it really cheap once again to get oil and gas out of the ground or 2) we could have a deep and grinding deflationary depression that brings demand for oil and natural gas down so much that prices collapse.

Here's why: The full cost of producing new oil for the 50 largest publicly traded oil companies in the world is $92 a barrel according to Bernstein Research. While average costs are lower because they include previously discovered conventional oil which is cheaper and easier to produce, the Bernstein report challenges the notion that new technologies will lead to cheaper oil. Those technologies including hydraulic fracturing will make it possible to extract previously uneconomic oil resources--but only at very high and rising costs. In fact, the cost of producing the marginal new barrel of oil has been rising at 14 percent per year since 2001, Bernstein says. Finding, developing and producing new oil isn't getting cheaper; it's getting much more expensive. So while oil prices could fall below the cost of producing new barrels for a while, they simply could not stay there unless the world were to become content with ever shrinking supplies of oil. No company will continue to drill for oil when each new well loses money.

So given that the world will probably continue to seek expanded supplies of oil, prices in the long run below $92 a barrel seem implausible. And, that floor is likely to rise as the oil resources that companies are now forced to pursue become costlier and more difficult to extract. We've already extracted the easy-to-get oil in the first 150 years of the oil age; now comes the hard stuff.

All of this flies in the face of the current popular meme that the United States and perhaps even the world will enjoy both cheap and plentiful supplies of oil and natural gas for the foreseeable future (whenever that is). Keep in mind that the costs cited above include the use of the latest technology. That tells us that depletion is long since winning the contest with technology. Yes, technology has helped to mitigate the damage that constrained energy supplies are inflicting on the world economy. Without it, matters would be much worse. But it is clear now that technology will no longer be able to overcome the fact that we as a species have used up the easy-to-extract hydrocarbons. We are now faced with exploiting ever leaner resources with diminishing returns on ever higher investments. In fact, record investment in finding and developing new oil resources has only just kept the rate of worldwide oil production on a choppy plateau since 2005.

When it comes to oil, major agencies such as the U.S. Energy Information Administration and the International Energy Agency recognize this reality and predict continuing high oil prices. But neither seems to understand the relevant data about U.S. natural gas extraction costs that also spell higher U.S. natural gas prices unless the country chooses miraculously to use a lot less. (The United States is now actually choosing to use more natural gas which is logical since the price of competing energy sources is currently so much higher on an energy equivalency basis.)

Of course, it's possible that someone could invent new technology that will make it much cheaper to extract the remaining hard-to-get oil and natural gas. But even if they do, as I have said before, if that technology is not on the shelf and ready to deploy today, it will make almost no difference in the next two decades. It takes a very long time for new technology to be adapted for use in the field, tested and then widely deployed. It took more than 60 years for hydraulic fracturing to move from field testing to regular use in vertical wells and then finally to a painstakingly expanded and refined technique that uses long horizontal wells to unlock oil and natural gas in deep shale deposits.

Currently, there appears to be no new transformative on-the-shelf technology that will significantly reduce the cost of extracting oil and natural gas. And so, barring a deep economic depression, we can look forward to prices for oil and natural gas that are consistently above the cost of production and therefore far above the bizarrely low forecasts in the air today. In fact, we should expect costs to continue to escalate as we seek out resources that are ever more difficult to extract and refine.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he writes columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin, The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.